Happy New Year! As if 2016 wasn’t tumultuous enough, 2017 promises to hold many more surprises. Here’s a selection of our best ideas from some of our favourite commentators…
Alphabet Inc. (Google) – Victor Hill
During 2016 I wrote more about Alphabet/Google (NASDAQ:GOOGL) than any other company. Reading around, I came to understand that Google is much more than an internet search engine which generates massive revenues from targeting ads with pin-point accuracy. It is a technology powerhouse at the centre of new convergent technologies which will very soon change the world.
Self-driving cars, data mining in healthcare, artificial intelligence, quantum computing… Google, uniquely, is at the forefront of all these mind-blowing technologies and will maintain its lead for the foreseeable future.
In May I wrote a piece entitled The Fly in Alphabet’s Soup. Back on 20 April the European Competition Commission charged Google with abusing its dominance of the Android operating system.
Android is the world’s most-used mobile phone operating system, powering about 1.8 billion devices. If the Commission could prove that Google has broken European competition law then it has the power to fine the company up to 10 percent of its global revenues.
The EU dismissed Google’s petitions on 14 July and even submitted additional charges – including one of evading taxes in Italy[i]. This dispute is likely to run on for years but the markets seem to have shrugged off initial concerns about its impact on revenues. By the time the case is resolved the technology will have changed anyway.
In June I considered the amazing potential of data mining in healthcare – a field in which Google has developed an important niche market through its UK subsidiary, DeepMind Technologies.
Under the terms of a contract with the NHS earlier this year DeepMind was given access to the anonymised records of 1.6 million NHS patients. Then at the end of November, DeepMind announced a parallel 5-year contract with the NHS to provide smartphone apps to clinicians to alert them of any deterioration in a patient’s condition[ii]. The future potential of this technology is awesome, though it some way off being fully monetised.
This is a technology that will not become main stream for perhaps another 20 years, but when it does it will speed up computer processing speeds exponentially and will make AI a reality. I quoted something I found on the Google Research webpage: We are particularly interested in applying quantum computing to artificial intelligence and machine learning[iii].
Google’s driverless car project has finally graduated from Alphabet’s research lab to become a stand-alone company called Waymo. But while Google expects Waymo to become a revenue source soon, it has been accused of failing to articulate Waymo’s revenue model.
…sometime during 2017 the market is going to realise that Google has a potentially massive new revenue stream here and its share price will respond accordingly.
What is clear is that Waymo, unlike Tesla (NASDAQ:TSLA), is not going to make cars. Rather, it will license technology to automobile manufacturers.
There is certainly competition in this space. General Motors (NYSE:GM) recently acquired Cruise Automation, and Tesla’s Autopilot system has clocked up more hours of driverless travel than Google/Waymo. Apparently, Toyota Motor Corp (TYO:7203) has over 1,000 patents outstanding relating to self-driving cars whereas Google has “only” a few hundred.
No doubt all shall become clear in the fullness of time. My best guess is that sometime during 2017 the market is going to realise that Google has a potentially massive new revenue stream here and its share price will respond accordingly.
Alphabet’s fundamentals are all sound. Google announced its Q3 2016 results on 27 October. Ruth Porat, Alphabet’s CFO, revealed year-on-year revenue growth of 20 percent, and 23 percent on a constant currency basis. Total revenues for the quarter were US$22.451 billion.
“Mobile search and video are powering our core advertising business and we’re excited about the progress of newer businesses,” Porat observed[iv]. Non-GAAP net income for the quarter was US$6.326 billion as compared to US$5.102 billion in Q3 2015. That translated into a diluted quarterly EPS of US$9.06 per share.
The share price started 2016 at around the US$760 level and took a knock over the summer, falling to a low as US$681 on 27 June on account of the European ruling. At the time of writing (just before Christmas) the shares are trading at US$812.50 indicating a current P/E ratio of 29.2 and a market capitalisation of just under US$550 billion.
The results for Q4 2016 will be announced on Thursday, 26 January 2017. The auguries are auspicious.
The Ruffer Investment Company – Nick Sudbury
I expect the markets to be highly volatile in the first part of 2017 as they adjust to the prospect of inflationary policies under President Trump and higher US interest rates. This should help to support the value of the dollar on the foreign exchanges and will induce import-led inflation in the UK. The triggering of article 50 will kick start the Brexit negotiations and add to the uncertainty.
Against this sort of backdrop I want to be invested in a fund with a flexible, global mandate and a cautious, proven manager who is capable of protecting my capital and then taking advantage of the opportunities when they come along. There are several vehicles that could do this, but my favourite is the Ruffer Investment Company (LON:RICA).
The RICA portfolio has been designed to protect investors from the harmful consequences of events that the managers foresee coming down the road. The main threat that they anticipate is the return of inflation and that real interest rates will move into negative territory, although they are mindful of the other risks along the way.
In order to protect against higher inflation they have invested 48% of the fund in UK and US inflation-linked government bonds and gold. The recent spike in bond yields – in anticipation of higher nominal interest rates – was really painful for these holdings, but the managers had cleverly hedged the risk by using interest rate options and Japanese financials to offset the falling bond prices.
The fund aims to achieve a positive total annual return, after all expenses, of at least twice the Bank of England Bank Rate and over the last 10 years it has generated a share price total return of 132.7%. If you want a fund that is capable of delivering steady performance in 2017 then look no further.
Short Turkish Lira – Filipe R. Costa
The second half of 2016 has been filled with game-changing events that have turned the world upside-down and challenged the geopolitical status quo.
In continental Europe, the population announced they had had enough of the current growth model (or lack of it); in the UK, the British turned their backs on the authoritarian European Union; and in the U.S., Trump emerged as the new president.
All these events threaten the current trend and thus may help to break the vicious cycle that unites deflation and sluggish growth.
In the UK, during the autumn statement, Chancellor Philip Hammond scrapped George Osborne’s budget targets to balance the government budget by 2020, announcing plans to carry on borrowing and spending for longer. In the U.S., during the presidential campaign, Donald Trump announced its intentions to spend the country’s money in infrastructure.
With fiscal spending increasing on top of very low interest rates and large central bank balance sheets, I expect consumer inflation to accelerate in 2017 and then press central banks towards tightening.
Some countries, like Turkey, are at the top of the vulnerability list, because their economic conditions are fragile and inflation is already above target.
A rise in yields in the developed world will lead to outflows of money from some emerging markets in the direction of the developed world. Some countries, like Turkey, are at the top of the vulnerability list, because their economic conditions are fragile and inflation is already above target.
Pressed by President Erdogan, the CBRT has been cutting interest rates since mid 2014. But the Trump win sent the Turkish lira into a downward spiral and forced the CBRT to reverse the interest rate cut. In November, it had to hike the lending rate from 8.25% to 8.50%, but it resisted hiking it again in December.
The central bank is between a rock and a hard place: failing to hike rates will lead to the slump of the Turkish lira and push inflation higher; but hiking rates will not be enough to sustain the lira decline and will at the same time lead to an economic slump at a time when the economy is fragile.
One way or another, I believe the lira will see difficult times. I’m long on USD/TRY which currently trades at the rate of 3.50 lira per each dollar.
A complementary option would be to short a basket of emerging market currencies, which would include the Malaysian ringgit, the Singaporean dollar, the South Korean won, the Indonesian rupiah and the Indian rupee. Or, put another way, go long on the U.S. dollar against those currencies.
AstraZeneca – Robert Stephens, CFA
My top pick for 2017 is AstraZeneca (LON:AZN). I think it is the right stock, at the right time. I believe that 2017 will be an uncertain year for global stock markets, thereby making defensive stocks more appealing. Higher yielding shares could also become popular, since inflation is forecast to hit at least 2.7%.
Furthermore, EPS growth could be more difficult to come by as challenges in the Eurozone, China and US come to the fore. Due to AstraZeneca’s low positive correlation with the economy and its high yield, it could therefore be a strong performer in 2017.
The next year is difficult to forecast. A new US President will represent a shift away from the status quo, but we currently have little idea of exactly what he will do. His economic policies could be a huge success and reinvigorate the US economy, or he could prove to be naïve and divisive. Either way, a switch back and forth between risk on and risk off trades could ensue as investors become indecisive about how the world economy will perform.
Additional risks include the pending discussions between the UK and the EU as well as a Chinese economy which may yet falter if supportive fiscal and monetary policies are withdrawn. Therefore, I think that defensive stocks could become more appealing. AstraZeneca may have struggled in recent years to face up to its patent cliff, but it remains a company with obvious defensive characteristics.
Next year could also see investors turn to high yielding stocks. Inflation is already on the up and reached 1.2% in November. It is expected to be as high as 3% or 4% within the next year, meaning that a large proportion of mid and large caps will offer negative real yields. Therefore, I believe that demand for stocks which yield over 4% at this moment in time could rise, which may compress their yields during the course of 2017.
Although AstraZeneca has seen its EPS fall in recent years as its sales have tumbled, its dividends have been maintained. They are expected to represent around 72.5% of EPS in 2017, giving the pharmaceutical company a prospective yield of just over 5%. Therefore, even if profit slides further in 2018, its dividends are relatively safe.
In a year in which growth may be tough to come by as a result of the aforementioned risks to global economic growth, AstraZeneca’s dependence on the patent cycle could prove appealing. Its EPS is more closely aligned to the strength of its pipeline and its ability to continue to leverage free cash flow to make acquisitions, rather than on GDP growth rates.
Its pipeline has improved markedly under current management and is now simpler and more focused. In my view, it sets the company up for growth further down the line which could start to be factored in next year. Due to this growth potential, its dividend appeal and defensive characteristics, I believe that AstraZeneca will perform relatively well in 2017.
Gateley Holdings – Richard Gill, CFA
While the result of 2016’s EU referendum was bad for some, there is one particular sector which looks set to benefit from the uncertainty surrounding Brexit into 2017 and beyond.
According to The Law Society, the representative body for solicitors in England and Wales, the referendum result will “…lead to a surge in demand for legal expertise and guidance.” – a point I also heard star fund manager Gervais Williams make in a pre-referendum debate. So where better to look than London’s only listed law firm, Gateley Holdings (LON:GTLY).
Operating throughout England and Scotland and with an office in Dubai, Gateley made the move from an LLP to a PLC in June 2015 when it listed on AIM, raising £5 million in the process. The firm specialises in commercial law, having a strong presence in the areas of Banking & Financial Services, Corporate & Business Services, Employment and Pensions & Property.
Providing its services to over 4,000 corporate and 1,500 private clients the company has over 150 partners and is regularly ranked in the top 50 UK based law firms by revenues. Some of the high profile deals recently worked on include the £307 million private equity-backed acquisition of the National Exhibition Centre Group (NEC) and the relocation of beleaguered West Ham United to the former Olympic Stadium.
Gateley came to market with a good track record, having grown revenues over the previous ten years by a compound annual growth rate of 14.3% and operating profits by 14.8%.
Gateley came to market with a good track record, having grown revenues over the previous ten years by a compound annual growth rate of 14.3% and operating profits by 14.8%. This was achieved via a mix of new office openings, an increase in the number of fee-earning lawyers and a number of earnings-enhancing acquisitions. Useful for those partner bonuses, but now for shareholders too, typical cash conversion stood at 95% every year for the previous three years.
The excellent progress has continued as a public company, with the 2016 financial year (to April) seeing revenues up by 10.2% at £67.1 million and pre-tax profits rising by 12.2% to £11 million. More recently, interims for the six months to June reported revenues up by a more pronounced 18% to £35.2 million and pre-tax profits up by 45% to £4.2 million. The good cash generation continued, with net debt falling from £12 million to £7.4 million, and trading for the rest of the year is expected to remain “robust”.
Providing further opportunities for growth in 2017, Gateley has recent expanded the business via acquisition, in line with its stated strategy at IPO. In April, Capitus, a specialist tax incentives advisory business, was added to the group, followed by Hamer Associates, a UK surveying business, in September. These deals look attractive as they diversify the company’s revenue base and also offer clients access to complementary services.
As I write shares in Gateley trade at 130.5p, up by 27% over 2016 and by 35% since IPO. At the current price they trade on a multiple of 13.2 times forecast earnings for 2017, falling to 12.2 times in 2018, which doesn’t look too demanding given the strength of the business. There is also a big income attraction here, with the shares currently offering a yield of just over 5% should, as expected a 6.59p payment be made for 2017.
Vast Resources (VAST) – Zak Mir
It is usually the kiss of death to back a minnow for the New Year, if only on the basis that there is usually an initial January hangover pullback – even if the call proves to be correct.
We have been treated to a rather painful ride in terms of the price action and the fundamentals of Romania focused miner Vast Resources (LON:VAST). Ironically the company was something of a small-cap investor darling before the early autumn 2015 peak through 2p. Since then we have suffered death by a thousand cuts in terms of the daily chart pattern, a process which only now at the end of 2016 really seems to be finally giving way.
The reason for the relative enthusiasm is the way it is possible to draw a broadening triangle in place on the daily chart with the turnaround backed by a clearance of the 50 day moving average and 200 day moving averages this week. This is a rare feat, and mirrors the fundamental breakthrough private equity funds circling the group’s assets.
The hope now is that for the start of 2017 we will see a higher low for the stock put in above the 200 day line now at 0.27p. Above this the implied technical target is as high as the top of a broadening triangle which can be drawn from March this year with its resistance line projection heading for 0.6p by the end of Q1 2017. At this stage only sustained price action back below the 50 day line at 0.18p would even begin to question the long argument.